Commercial Credit & Finance PLC

Credit Assessment Presentation

international rating on the conventional AAA-scale and national rating
proposal
Operating Environment Sri Lanka GDP per capita(USD)
4200

• The GDP per capita has taken a downturn from the USD 4000 level which 4100

Sri Lanka had achieved back in 2018. 4000

• This coupled with the downgrade of the Sri Lanka’s Long-Term Local- 3900

Currency Issuer Default Rating to 'CC', from 'CCC‘ on 1st December 2022, 3800

would create a challenging operating environment for finance and leasing 3700

companies sector, such as commercial credit. 3600

3500
• Furthermore, the monetary policy decisions undertaken by the regulator has 2015 2016 2017 2018 2019 2020 2021

caused slower credit growth and increased borrowing costs affecting the Source: World bank
finance and leasing sector(FLC), which is likely to persist in the short to
medium term.
Business Profile -Established franchise operating in a fragmented industry
Market Share
• Commercial Credit is a mid sized FLC with a 6.5% market share of FLC-sector loans and advances, with a significant
penetration into the rural areas of the country
• The foothold of the firm is strong, with a branch network of 133 branches spanning across the country.
• The firm maintains a longstanding focus on vehicle leasing and auto loans, and mainly caters 2W, 3W leasing products to
households who are more vulnerable to the economic cycles. Hence, we believe its business volumes will be significantly
dampened by higher interest rates coupled with lower disposable income of the population in the short term.
Competitive position
• In fragmented market which comprises of 38 players as at 1st December 2022, commercial credit does not seem to hold any
distinctive competitive advantage where price sensitive nature of consumers further elevates the competitiveness of the
licensed finance sector.
• However, the communication strategy adopted by the firm, which emphasizes good qualities of people was able to create a
strong brand image for the firm within the country.
Business Model - concentration on vehicle leasing and auto loans coupled with lack of product
diversification will hamper the growth prospects of the firm Product portfolio mix
Business mix and product concentration 2.81%
0.46% 6.64%

4.23%
• The core business products of the firm comprises of leasing and hire purchasing,
which collectively account to more than 70% of the interest income for the six 13.79%
29.70%

months ended 30th September 2022., while the other notable segments include
gold loans(14%) and micro finance(4%).
40.39%
• While the firm is heavily reliant on finance leasing and auto loans, it is observed
that the firm should diversify the loan portfolio to less risky segments such as term
loans, as the ban on vehicle imports coupled with higher second hand vehicle financ lease hire purchase gold loans micro finance

prices will continue to constrain the demand for vehicle leasing. term loans Revolving Loans Investments

Quarterly Earnings
Earnings Volatility
3,000

Millions
• On the scrutiny of past earnings, it is observed that business segments of leasing 2,500

and micro financing recorded QoQ declines of 38% and 9% respectively, for the 2,000
1QFY23, owing to the interest rate hikes, while the leasing segment recovered 1,500
strongly in 2QFY23 with interest income increasing by 49%.
1,000

• Hence, it is expected that the core business activities of commercial credit such as 500

leasing and hire purchase will continue to be affected by earnings volatility, as high 0
interest rate environments coupled with lower disposable income of the population finance leasing hire purchase gold loans micro finance

will lead to decline in demand for the core business products. Sep 2022 June 2022 Mar 2022 Dec 2021
Management Quality
Depth and Credibility of the Senior management - It is observed that the senior management are experienced professionals in
the finance and banking field.
• Furthermore, the senior management comprises of a good mix of executive and independent directors, comprising of individuals
with expertise in banking, risk management, micro financing and accountancy.
• The CEO of the firm, with prior experience in administration, also serves on the boards of several privately held companies and
have also held senior management positions in the field of finance.
Corporate Culture- The company considers that its unique culture based on purpose and shared values enable the firm to achieve a
competitive advantage.
• The Company practices an “open door policy” across all levels of the organization, and has moved away from a traditional
hierarchical work culture.
Key Person risk - It is observed that the major shareholder, Mr. R.S. Egodage who owns more than 50% of shares of the entity, is
also the CEO of the firm.
• It is noted that departure of Mr. R.S. Egodage from the entity will cause a significant disruption to the operations of the entity.
Management Strategy
Quantitative strategic targets - the strategic targets and goals of the entity have not been disclosed in order to ascertain whether
such targets and goals are achievable and sustainable.
Qualitative strategic framework –
• the company plans to support the customers who are experiencing difficult times from the current operating environment and
will continue to foster healthy relationships in order to mitigate the impact of the crisis.

• Further, the firm as a matter of priority will invest in effective learning infrastructure. Accordingly, no sound strategic
framework has been disclosed to determine how the entity will adapt to the challenging operating environment mentioned.
Management Strategy
Corporate Governance - The Board has adopted sound corporate governance framework, including separating the roles
of the CEO and the chairman, appointment of Non Executive directors to the board(more than 50% of the board are non
executive directors) and formulating Board Committees.

• However, with the appointment of the new Chairman, Mr. Bandula Egodage, it appears that the controlling positions
of the entity, namely CEO and Chairman positions are being held under the control of one family.

Protection of Creditors Rights- Backed by the commitment of the senior management to adhere to the values of the
firm and the integrity of the senior management comprising of a higher proportion of Independent Directors, it is safe to
assume that creditor protection will be safeguarded without suffering at the expense of other stakeholders.
Risk Profile Assessment
Risk management tools- the risk management tools used for internal purposes were not disclosed.
Risk Reporting- Commercial Credit implements a robust risk control system, where the Board of Directors is responsible
for establishing the overall risk management framework, while responsibilities are delegated to the Board Integrated Risk
Management Committee (BIRMC).
• A risk management process has been developed and is continuously reviewed by the BIRMC together with the
operational management, and risk sub committees, namely Credit Committee, Information Technology sub-committee
are entrusted with reviewing operational risks, while the Assets and Liabilities Committee (ALCO) reviews market and
liquidity risks.
• The risk sub committees comprise of selected members of the operational management, middle management and
operational staff of each relevant department and thereby ensures that risk control permeates all levels of the
organization.
Exposure to non Financial Risks - Commercial Credit has taken actions to mitigate cyber risk and data leakage prevention
by conducting periodic internal and external vulnerability assessments, timely patch upgrades/update databases, applications,
middleware and operating systems, strengthen the security measures
Exposure to Market Risks -

Interest Rate Risk- This refers to risk of losses from adverse interest rate movements. Increase in interest rates will mainly
impact the firm, through repricing risk.

Repricing Risk - This is where the entity is forced to reprice the interest bearing liabilities at a faster rate than interest bearing
assets. We believe commercial credit may be more susceptible to interest-rate risk amid sharply higher domestic interest rates, as
their mostly fixed-rate loans which comprise of leasing and hire-purchase tends to reprice more slowly than their liabilities.

• This coupled with the negative asset- liability maturity gap of 43% loss component of interest bearing assets observed for 3 to
12 months will force the entity to roll over excess interest bearing assets that mature in 3 months, for a further period. Such
would compel the firm to hold on to cash and cash equivalent assets further, hence reducing investments in loans and
advances that generate a higher return in the short term.

Foreign Exchange risk- This refers to the mismatches between foreign currency assets and liabilities of the firm. On
observation it is found that the company has no foreign currency obligations and assets, and does not involve in any cross border
operations, hence is not exposed to significant foreign exchange risk.

Market Risk Management- The company is following a robust market risk management framework through ALM policy,
treasury procedures and board- approved risk limits.
Financial Profile 15.00% Gross NPA vs Industry

Asset Quality 10.00%

Amidst the challenges faced in the operating environment, the asset quality metrics of the
firm had improved, backed by increases in the bad debt recoveries, which grew by 48% 5.00%

YoY and reached LKR 1.014 Bn as at 2QFY23.

0.00%
• The NPA ratio of the firm has witnessed a steady decline owing to improvements in 2021 2020 2019 2018
recoveries of by the firm. The Gross NPA of the firm improved to 4.67% in 2021 Commercial Credit Industry

from 5.39% in 2020.

• In the same note Stage 3 impairment to Stage 3 Loans too witnessed a decline 50.0%
Stage 3 Loans
6,000
recording 30% for FY 2022 from 32.7% in FY 2021.

Millions
40.0% 5,000

• In comparison, the NPA ratio of the firm is at par with the performance of the other 30.0%
4,000

key players in the industry and is significantly better than the industry. 20.0%
3,000

2,000
• The net impairment allowance charge off had improved to 0.8% of average loans in 10.0% 1,000
2022 from 1.55% in 2021 owing to increased bad debt recoveries made by the firm in 0.0% 0
the latest financial year. Gross NPA comparison with peers 2022 2021 2020 2019
14.00% Stage 3 Loans (RHS) Stage 3 impairment % (LHS)

12.00%
Net impairment allowance charge off
10.00% 4.00%

8.00% 3.50%
3.00%
6.00%
2.50%
4.00%
2.00%
2.00%
1.50%
0.00%
1.00%
FY 2022
0.50%
Singer Finance Commercial Credit Vallibel
0.00%
LB Finance LOLC Peoples Leasing 2022 2021 2020 2019
 Profitability 3,500
Return on Assets 14.00%

Millions
3,000 12.00%
The profitability of the firm had marginally recovered to 3.9% of average assets for 2,500 10.00%
2QFY23 from 3.7% witnessed in the 1QFY23, while the margins have declined by 21% 2,000 8.00%
compared to 2QFY22, owing to rising cost of deposits of the firm. 1,500 6.00%

• As a result of the interest rate hikes taken during the year, return on assets which 1,000

500
4.00%

2.00%
stood at 12.6% for the 1Q 2022, decreased to 3.7% by the 2Q 2022, backed by the 0 0.00%
decrease in net interest income for the period. Sep 2022 June 2022 Mar 2022 Dec 2021
Profit Before Tax (LHS) Return on Assets (RHS)
• The core earnings of the firm also followed suit, where the Adjusted EBITDA which
Core Earnings
recorded over 50% for 1QFY23, declined to 36% by 2QFY23. 4,000 70.00%

Millions
60.00%
Considering the lowered return on assets the implied factor b will be assigned to 3,000 50.00%

Commercial Credit with respect to earnings 2,000

40.00%

Capitalization and Leverage

30.00%

1,000 20.00%
• Leverage as measured by debt/tangible equity has marginally increased, recording 1.3x for 10.00%

2QFY23, from 1.2x in 1QFY23. This was backed by increase in financial obligations to 0
Sep 2022 June 2022 Mar 2022 Dec 2021
0.00%

other banks and was also affected by dividend payments made in 2QFY23. Adjusted EBITDA (LHS) EBITDA % (RHS)
 Funding and Liquidity Coverage Debt composition
• The financial flexibility of the firm, as reflected by its high share of public deposits (65% of
the funding), which was further supported by low secured debt/ total debt (48% as at FY 100%

2022), remained acceptable for the time period. 80%

• The firm, which relied on secured debt to fund more than 60% of the debt funding in FY 60%

2020, is now relying more on direct bank borrowings in FY 2022(43% of total debt as at FY 40%

22). 20%

• The interest coverage ratio of the firm, which stood more than 2x in 4QFY22, had drastically 0%
2022 2021 2020 2019
reduced below 1x in 1QFY23 and 2QFY23 respectively. Bank Overdraft Direct Borrowings

Liquidity secured debt

3,500
Interest Coverage
Debenures and commercial papers
2.50

Millions
• The firm has continued to maintain sufficient liquid assets in the balance sheet, 3,000
2.00
maintaining a liquidity ratio of 1.4x as at 2Q FY23 and has consistently 2,500
1.50
maintained a liquidity buffer above 1.2x in order to compensate current 2,000
1,500
liabilities. 1.00
1,000
0.50
Liquidity Position 500

9,000 1.80 0 0.00

Millions

Sep 2022 June 2022 Mar 2022 Dec 2021

8,000 1.60
Interest expenses (LHS) Adjusted EBITDA/ Interest (RHS)
7,000 1.40
30,000
Secured Debt 70%
6,000 1.20

Millions
5,000 1.00 25,000 60%
4,000 0.80 50%
3,000 0.60 20,000
40%
2,000 0.40 15,000
1,000 0.20 30%
0 0.00 10,000
20%
Sep 2022 June 2022 Mar 2022 Dec 2021
5,000 10%
Cash and marketable securities (LHS) liquidity ratio (RHS)
0 0%
2022 2021 2020 2019
Total Debt (LHS) Secured debt % (RHS)
 Government support and shareholder support
Owing to the firm being a highly integrated subsidiary, where the ownership of the firm as well as the key
managerial positions are held within a single family, no government support or shareholder support ratings will be
assigned to the entity.
Rating Rationale under selected criteria
Criteria Implied Score Rationale

Operating Environment
Business Profile
Management and Strategy
Risk Profile assessment
Financial Profile
B Substituting the short term political risk index score of 54 to
the operational risk index score, along with the lower
GDP/capita of the country.
BBB Owing to core business products being impacted by the
challenged operating environment and backed by limited
competitive advantages and pricing power and less diversified
business model
BBB In consideration of the well qualified senior management
having a good degree of depth, and experience, while key
person risk is moderate
BBB Owing to robust risk reporting and strong risk controls
implemented by the organization at all levels
BBB Due to stable asset quality indicators, while earnings and
profitability may be variable over economic and/or interest
rate cycles.

Considering the stand- alone assessment indicators indicated above, The following rating actions are proposed. (i) CCC international
rating on the conventional AAA-scale (Sri Lanka sovereign Foreign-Currency Long-Term Issuer Default Rating: Restricted Default;
Local-Currency Long-Term Issuer Default Rating: CCC/Under Criteria Observation)
(ii) national rating on the local national rating scale of ‘BBB(lka)’ on Rating Watch Negative for Commercial Credit and Finance PLC